CNBC's Rick Santelli on the parlour game that is Quantitative Easing

Courtesy of Zero Hedge, will we ever see 'reality' again? Judging by CNBC's Rick Santelli's one-sentence epic rant Friday morning of the centrally-planned farce that we are living through... no. This exchange is in the clip above:

Liesman: "Why would you normalize rates?" 

Santelli: "Are we really that far down the hole that normalizing rates after this tremendous number - the huge drop in the unemployment rate - that you guys still wanna have the hammer-and-sickle on the flag"

So the short answer, it appears, is 'No'.

But perhaps it is Rick's seething anger in a second clip that exposes the reality of "the apologists" for the Fed and as he notes: "This whole thing is a Parlor Game and the country deserves better than Fed experimentation." 

Later in the day - an even more epic-er exchange.  In Liesman and Santelli II:

Liesman: "The Fed is doing the only thing it knows" 

Santelli: "The economy is better despite them." 

Anchor: "Where would we be today without the Fed?" 

Santelli: "We'd be significantly better now! What wouldn't have been significantly better is the one-year after the crisis - that would have been worse - but we would have been 'on the mend' Sam Zell-style, we would have hit a 'real' bottom."

Rick Santelli is so right.  The pain would have been sever, but malinvestment would have been cleared away and we would have had a genuine recovery by now.  Instead we are looking at a 'crisis' situation for years to come yet.

Both clips are well worth watching if economic policy interests you.

   

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Open ended QE announced!

QE3 is here, and it's pretty big.

They've announced a form of "open-ended" quantitative easing in which the central bank commits to "purchasing additional agency mortgage-backed securities at a pace of $40 billion per month."

But there's something much much much more important here than the numbers. It's the guidance:

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.

The key thing is that the Federal Reserve Open Market Committee is no longer saying that accommodative monetary policy is conditional on the recovery being weak. Instead, interest rates will stay low for a while even after the economy recovers.

Open-ended Quantitative Easing. It appears QE to Infinity is a reality.

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The Emperor is naked

Faithful readers know we keep a keen eye on monetary policy, both in Canada and abroad, because our housing bubble in intertwined with it.

And today's post is a long one on just that topic: monetary policy.

In the past we have posted about David Stockman, a former U.S. politician and businessman who served as a Republican U.S. Representative from the state of Michigan from 1977–1981.

He is, however, more well known as the director of the Office of Management and Budget under President Ronald Reagan from 1981–1985 and has been a keen critic of US monetary policy.

Recently he has spent a considerable amount of time talking and writing about the effect of government-funded, debt-fueled spending on the stock market and the ultimate effect of Quantitative Easing.

The respected Stockman believes we are in the last innings of what he describes as "a very bad ball game. We are coping with the crash of a 30-year–long debt super-cycle and the aftermath of an unsustainable bubble."

As for Quantitative Easing, Stockman contends it is making the situation worse by facilitating more public-sector borrowing and preventing debt liquidation in the private sector — both erroneous steps because they prevent the US federal government from getting its financial house in order.

Says Stockman:

"We are on the edge of a crisis in the bond markets. It has already happened in Europe and will be coming to our neighborhood soon."

To Stockman the cause of the crisis is the US Federal Reserve.

"The Fed is destroying the capital market by pegging and manipulating the price of money and debt capital. Interest rates signal nothing anymore because they are zero. The yield curve signals nothing anymore because it is totally manipulated by the Fed. The very idea of "Operation Twist" is an abomination.

Capital markets are at the heart of capitalism and they are not working. Savers are being crushed when we desperately need savings. The federal government is borrowing when it is broke. Wall Street is arbitraging the Fed's monetary policy by borrowing overnight money at 10 basis points and investing it in 10-year treasuries at a yield of 200 basis points, capturing the profit and laughing all the way to the bank. The Fed has become a captive of the traders and robots on Wall Street.

Stockman believes the Fed needs to get out of the way and not act like it is the central monetary planner of a $15 trillion economy.

But because they will not get out of the way, he believes we are in the final innings of a debt super-cycle. And what is the catalyst that will end the game?

"I think the likely catalyst is a breakdown of the U.S. government bond market. It is the heart of the fixed income market and, therefore, the world's financial market.

Because of Fed management and interest-rate pegging, the market is artificially medicated. All of the rates and spreads are unreal. The yield curve is not market driven. Supply and demand for savings and investment, future inflation risk discounts by investors—none of these free market forces matter. The price of money is dictated by the Fed, and Wall Street merely attempts to front-run its next move. As long as the hedge fund traders and fast-money boys believe the Fed can keep everything pegged, we may limp along. The minute they lose confidence, they will unwind their trades. On the margin, nobody owns the Treasury bond; you rent it. Trillions of treasury paper is funded on repo: You buy $100 million (M) in Treasuries and immediately put them up as collateral for overnight borrowings of $98M. Traders can capture the spread as long as the price of the bond is stable or rising, as it has been for the last year or two. If the bond drops 2%, the spread has been wiped out. If that happens, the massive repo structures—that is, debt owned by still more debt—will start to unwind and create a panic in the Treasury market. People will realize the emperor is naked."

Stockton believes 2008 was a dry run of what happens when a class of assets owned on overnight money goes into a tailspin: there is a thunderous collapse.

2008 was one of those 'thunderous collapses' . It occurred in the repo market for mortgage-back securities, credit default obligations and such. Since then, the repo trade has remained in the Treasury and other high-grade markets because subprime and low-quality mortgage-backed securities are dead.

So does Stockton foresee another 'thunderous collapse'? And if so, how it could all unwind? What happens when the fast-money traders lose confidence in the Fed's ability to keep the spread?

"They are forced to start selling in order to liquidate their carry trades because repo lenders get nervous and want their cash back. However, when the crisis comes, there will be insufficient private bids—the market will gap down hard unless the central banks buy on an emergency basis: the Fed, the European Central Bank (ECB), the people's printing press of China and all the rest of them.

The question is: Will the central banks be able to do that now, given that they have already expanded their balance sheets?  The Fed balance sheet was $900 billion when Lehman crashed in September 2008. It took 93 years to build it to that level from when the Fed opened for business in November 1914. Bernanke then added another $900B in seven weeks and then he took it to $2.4 trillion in an orgy of money printing during the initial 13 weeks after Lehman. Today it is nearly $3 trillion. Can it triple again? I do not think so. Worldwide it's the same story: the top eight central banks had $5 trillion of footings shortly before the crisis; they have $15 trillion today. Overwhelmingly, this fantastic expansion of central bank footings has been used to buy or discount sovereign debt. This was the mother of all monetizations."

Following that path, what happens if there are no buyers? Do the governments go into default?

"The U.S. Treasury needs to be in the market for $20B in new issuances every week. When the day comes when there are all offers and no bids, the music will stop. Instead of being able to easily pawn off more borrowing on the markets—say 90 basis points for a 5-year note as at present—they may have to pay hundreds of basis points more. All of a sudden the politicians will run around with their hair on fire, asking, what happened to all the free money?"

Stockton sees this mayhem stretching into the private sector as well. Once the bond market starts unraveling, all the other risk assets will start selling off like mad.

"If the bond market goes into a dislocation, it will spread like a contagion to all of the other asset markets. There will be a massive selloff.

I think everything in the world is overvalued—stocks, bonds, commodities, currencies. Too much money printing and debt expansion drove the prices of all asset classes to artificial, non-economic levels. The danger to the world is not classic inflation or deflation of goods and services; it's a drastic downward re-pricing of inflated financial assets."

Stockton does not see any way to unravel this without this massive dislocation.

"The Fed is now at the end of a $3 trillion limb. It has been taken hostage by the markets the Federal Open Market Committee was trying to placate. People in the trading desks and hedge funds have been trained to front run the Fed. If they think the Fed's next buy will be in the belly of the curve, they buy the belly of the curve. But how does the Fed ever unwind its current lunatic balance sheet? If the smart traders conclude the Fed's next move will be to sell mortgage-backed securities, they will sell like mad in advance; soon there would be mayhem as all the boys and girls on Wall Street piled on. So the Fed is frozen; it is petrified by fear that if it begins contracting its balance sheet it will unleash the demons."

Stockton takes issue with the idea that the banking system was threatened in 2008 and needed Fed action.

"The banking system, especially the mainstream banking system, was not in peril at all. The toxic securitized mortgage assets were not in the Main Street banks and savings and loans; these institutions owned mostly prime quality whole loans and could have bled down the modest bad debt they did have over time from enhanced loan loss reserves. So the run on money was not at the retail teller window; it was in the canyons of Wall Street. The run was on wholesale money—that is, on repo and on unsecured commercial paper that had been issued in the hundreds of billions by financial institutions loaded down with securitized toxic garbage, including a lot of in-process inventory, on the asset side of their balance sheets.

The run was on investment banks that were really hedge funds in financial drag. The Goldmans and Morgan Stanleys did not really need trillion-dollar balance sheets to do mergers and acquisitions. Mergers and acquisitions do not require capital; they require a good Rolodex. They also did not need all that capital for the other part of investment banking—the underwriting business. Regulated stocks and bonds get underwritten through rigged cartels—they almost never under-price and really don't need much capital. Their trillion dollar balance sheets, therefore, were just massive trading operations—whether they called it customer accommodation or proprietary is a distinction without a difference—which were funded on 30 to 1 leverage. Much of the debt was unstable hot money from the wholesale and repo market and that was the rub—the source of the panic. Bernanke thought this was a retail run à la the 1930s. It was not; it was a wholesale money run in the canyons of Wall Street and it should have been allowed to burn out."

And when the inevitable unwinding of the Fed and the bond markets comes, it won't put the banking system back in peril. The people were lied to in 2008. And when unwind comes, when the next crisis starts, Stockton believes we will "see torches and pitch forks moving in the direction of the Eccles building where the Fed has its offices."

Stockton also believes that moment is closer than most people think.

"On Dec. 31, the tax cuts will expire, defense cuts go into place and we hit the debt ceiling. That will be a clarifying moment; never before have three such powerful vectors come together at the same time — fiscal triple witching.

First, the debt ceiling will expire around election time, so the government will face another shutdown and it will be politically brutal to assemble a majority in a lame duck session to raise it by the trillions that will be needed.

Second, the whole set of tax cuts and credits that have been enacted over the last 10 years total up to $400 – 500B annually will expire on Dec. 31, so they will hit the economy like a ton of bricks if not extended.

Third, you have the sequester on defense spending that was put in last summer as a fallback, which cannot be changed without a majority vote in Congress.It is a push-pull situation: If you defer the sequester, you need more debt ceiling. If you extend the tax expirations, you need a debt ceiling increase of $100B a month.

Congress will extend the whole thing for 60 or 90 days to give the new president, if he hasn't demanded a recount yet, an opportunity to come up with a plan.

To get the votes to extend the debt ceiling, the Democrats will insist on keeping the income and payroll tax cuts for the 99% and the Republicans will want to keep the capital gains rate at 15% so the Wall Street speculators will not be inconvenienced. It is utter madness.

If the debt ceiling is raised again, defense purchases and non-defense purchases will be hit with brutal force by the sequester. As we go into 2013, there will be a shocking hit to the reported GDP numbers as discretionary government spending shrinks. People keep forgetting that most government spending is transfer payments, but it is only purchases of labor and goods that go directly into the GDP calculations, and it is these accounts that will get smacked by the sequester of discretionary defense and non-defense budgets.

In this environment unemployment numbers will soar.

So in the midst of this volatility, how can normal people preserve, much less expand their wealth?

"The only thing you can do is to stay out of harm's way and try to preserve what you can in cash. All of the markets are rigged or impaired. A 4% yield on blue chip stocks is not worth it, because when the thing falls apart, your 4% will be gone in an hour."

But if the government keeps printing money, won't cash be rendered worthless too?

"I do not think we will have hyperinflation. I think the financial system will break down before it can even get started. Then the economy will go into paralysis until we find the courage, focus and resolution to do something about it. Instead of hyperinflation or deflation there will be a major financial dislocation, which means painful re-pricing of financial assets.

How painful will the re-pricing be? I think the public already knows that it will be really terrible. 

My investing model to deal with all of this is ABCD: Anything Bernanke Cannot Destroy.

And if you read this blog regularly... you know the the tangible items Stockman is referring to.

Primarily Gold and Silver.

But you knew we were going to end up with this, didn't you?

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All you need to know about money printing

A few days ago there was another significant round of currency debasement.  Quantitative Easing (QE) is  taking place on a massive scale despite the fact you are not hearing about it in the mainstream press.

If the basic definition of quantitative easing (QE) is a significant increase in a central bank's balance sheet via increasing banking reserves, then all eight of these central banks [the others include the Bank of England, the Swiss National Bank, the Banque de France and Germany's Bundesbank] are engaged in QE (see graph above -click to enlarge).

What's particularly shocking about the data is that while every major central bank is busily printing money like it's going out of fashion – which it is – one of the biggest culprits is the one most widely associated with sound monetary policy, namely the Bundesbank, which has been one of the biggest inflationists of all:

The combined size of the Big 8 central banks' balance sheets has almost tripled over the last six years, from $5.4 trillion to more than $15 trillion and still rising. That $15 trillion compares with the capitalisation of world stock markets which stands at $48 trillion. The Big 8 central banks now account for the equivalent of one third of world stock market capitalisation.

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Fri Post #1: Vancouver Sun - 'We’ve been down this path before'

Frank Giustra is a Vancouver business executive with interests in the mining and filmmaking industries, and a noted philanthropist.

Yesterday, in the Vancouver Sun, he had an OpEd piece about the massive bailout in Europe this week.

That sentiments like his are now appearing in the mainstream media demonstrate the turning tide for public opinion on precious metals.

For your consideration...

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We’ve been down this path before

As civilizations mature, they tend to make the same mistakes. We are in the middle of one of those mistakes right now

The type of economic restructuring both America and Europe need is so difficult and painful that, even if the current political systems were functioning, it would still take many years and the kind of courage and sacrifice that does not seem to exist.

“What has been will be again, what has been done will be done again; there is nothing new under the sun.” Ecclesiastes 1:9

If, as an investor, you are looking at the U.S. and Europe, and are confused by the barrage of sombre news relating to economic issues — such as stubbornly high unemployment, collapsing housing prices, soaring government-debt levels, waning consumer confidence and a precarious banking system — I don’t blame you. As far as I can tell, so are the legions of experts, media and politicians, those we have traditionally trusted to explain such complex economic and financial matters to us. And why have all the herculean efforts to save us from these maladies failed so miserably, despite the fact that we seem to be drowning in remedies?

It seems as though America and Europe are going down for the count. As Canadians, we have a solid financial system and a stable government that functions as it was designed to do. And yes, we Canadians can take comfort that we are somewhat shielded from the profligate and irresponsible policies of our American and European friends, but given their sheer size and our inter-connectedness, we can’t completely escape the collateral damage when the stuff eventually hits the fan.

As the above Ecclesiastes quote (generally attributed to King Solomon) suggests, history is replete with examples of repetitive behaviour. Observing the behaviour of today’s policy-makers, I suspect this quote is as valid today as it was more than two millennia ago.

We are in an unholy mess and however loudly the sane few may plead, the chances it will get turned around without disaster striking are slim indeed. The type of restructuring both America and Europe need is so difficult and painful that, even if the current political systems were functioning, it would still take many years and the kind of courage and sacrifice that does not seem to exist. One of these days, some unforeseen event, akin to the child in Hans Christian Andersen’s The Emperor’s New Clothes declaring “But he isn’t wearing anything at all!” may serve as the tipping point that brings the entire financial system to its knees.

To get a proper understanding of the current situation, we should start by ignoring all the noise propagated by the experts, media and elected officials.

Our global financial system is based on the very simple and fragile concept of confidence. So you can’t really blame the policy-makers and politicians for not telling the public the “entire” truth; feeding us constant reassurances, peppered with a little mendacity. And to make things worse, it’s just human nature for us, the recipients of this information, to reject the idea that the worst can happen, hence our willingness to find reassurance in the misinformation we are fed. But folks, the worst CAN happen.

I doubt the citizens of Imperial Rome ever considered that their empire, which stretched from the Atlantic Ocean to the Caspian Sea, would eventually collapse on itself from the sheer weight of effort and resources needed to maintain it, or that 16th-century Spaniards ever thought their high standard of living, sustained by the plundered riches of the New World, would disintegrate once the supply of gold dwindled.

Or that the upper-class 19th-century Brits leading up to 1918 ever fathomed that the sun could cease to set on lands ruled by the British Empire. History has shown that when great nations mature and over-extend themselves, they revert to the paths of least resistance: borrow and/or print money. They all did it and they all failed; this time will be no different.

If Einstein’s definition of insanity — doing the same thing over and over again and expecting different results — holds true, we should move to have all of America’s and European policy-makers locked up in padded cells.

This hubris — holding on to time-worn ideas about what made a nation great in the first place, but ignoring the hard sacrifice that went with it — has prevailed throughout history and is as relevant today as it was for every great nation that came before America and the European Union.

Still, the “experts” continue to reassure us that America was built on a foundation of entrepreneurial spirit; we can get ourselves out of any mess. (At least the Europeans know better than to preach such fantasy.) I sense that some of those ideas don’t hold up as well as they once did, especially as the world outside of America has become highly competitive.

At some point in the evolution of a great nation must come a time when the simple math of mounting debt, lack of productivity and printed money plays havoc with ingrained beliefs. This is one of those times in history.

Therefore, as much as I would love to provide solutions to this mess-in-waiting, I would rather give some thoughts as to how to protect yourself.

Consider the following precaution as a condom for your portfolio or savings: protection against STDs (savings’ total destruction).

The bottom line is that the money needed to bail out Europe and to fund America’s spiralling debt and future unfunded obligations is in the tens of trillions. IT DOES NOT EXIST. It has to be created by printing money in massive quantities, and despite all the rhetoric you will hear against such policies, in the end it’s the path of least resistance. Printing money is an invisible tax on savings, much easier to initiate, than, say, raising taxes or cutting back on services and entitlements.

However, there is a lag on its negative effects, a perfect policy tool for elected officials who inevitably kick the can down the road to future governments. Policy-makers in most democracies live in a 24/7 campaign mode, which prevents them from making difficult, long-term and most certainly unpopular decisions. Simply said, we operate in a system not conducive to decisive action.

Witness last week’s dismal failure by the U.S. Congressional Super Committee to reach agreement after months of bitter negotiating on what was essentially a ridiculously minuscule reduction of the deficit over the next decade and you get the picture.

There will be a quantitative easing three (QE3) in the U.S. and the European Central Bank (ECB) will eventually follow suit in printing money in American-style amounts, despite Germany’s resistance to date.

If the world continues to print money, currencies will be debased against “tangible things” such as gold, farmland, exclusive real estate, rare art and collectibles, select equities to list a few. Therefore, having your savings invested in cash, bonds, money and markets, could mean a complete destruction of those savings by runaway monetary inflation.

Having said that, timing is an issue you must weigh carefully. There is a chance that another financial crisis such as we experienced in 2008 would cause the value of real assets to go down and, by definition, make cash holdings more valuable for a short period of time, until further “printing” reverses the trend once more.

I would recommend owning plenty of gold and, depending on your available resources, select real estate and collectible art, which works well for wealth preservation, and having an adequate pool of cash, which would only be used to acquire additional “real assets” in the event of another crisis.

It’s your wealth, your life savings; you are the only person who can protect it.

No one else really cares.

Wake up and smell your future.

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The End of QE?

Michael Krieger was formerly a macro analyst at Bernstein Research (widely recognized as Wall Street's premier sell-side research firm) and currently runs his own fund, KAM LP.

He has come out with some thoughts on the US Federal Reserve's on going money printing and the ensuing current propaganda that is flooding the financial news waves.

Kreiger classifies US Federal Reserve Chairman Ben Bernanke as a misguided Keynesian witch doctor central planner who is attempting a grand experiment based on completely insane and nonsensical theories that have no chance at success.

He argues that Bernanke claims to have all sorts of “tools” but in reality he has nothing.

When faced with a complete credit collapse of proportions never seen before in recorded history there were and are only two “tools.” And those 'tools' are the two P’s: Printing and Propaganda.

And Kreiger laments the propaganda tool is in full vigor right now.

He reminds us of that which we alreday know: that the central planners believe the tail wags the dog.

To them, the economy doesn’t lead to higher stock prices but higher stock prices will lead to a better economy.

Insane?

Absolutely. But it is the religion of the central planners... 100%.

And Kreiger cautions that investors need to be aware that - when they are comparing the current state of affairs to what many lived through in the 1970’s - that the central planners have learned some lessons.

Central planners will never renege on their core philosophy which is that an elite academic and political class in their wisdom are better stewards than free humans interacting in a marketplace.

That said, most people do not share their worldview for obvious reasons (who wants their lives micromanaged) so the trick of the central planners is to micromanage your life while you think you are in charge.

As Goethe said “None are more hopelessly enslaved than those who falsely believe they are free.”

He didn’t just make up this clever quote, it is a tried a true method of the most successful control systems throughout history. 

Price controls were tried in the 1970’s and failed. We also know why. Therefore, the last thing the current group of central planners will want to do is announce price controls. That doesn’t mean they don’t attempt them anyway.

Bernanke has already publicly proclaimed he is attempting to inflate the stock market through direct intervention.  They have been rigging stocks in the United States consistently for the past two years and most people get this and accept it as a part of the current state of emergency economic action we are in.

Kreiger now argues we have now entered Phase 2 of that action. This was represented by the recent raid on commodities. 

• A tried and true strategy that the powers that be have used in precious metals for years has been to create such tremendous volatility in gold and silver and especially the shares that most investors stay away since they can’t stomach it. This strategy is now seemingly being employed to a much wider spectrum of commodities.  Unfortunately, this battle between finding a safe haven and the authorities’ desire to render it ‘unsafe’ is only in its earliest stages. Our manta since 2007 – governments can and will do anything to survive.

Kreiger asks you to put yourself in The Bernank’s shoes for a moment. This guy loves printing more than Hewlett Packard. He is despondent beyond belief that the markets and an increasing amount of financial commentators have criticized his precious QE insanity.

Meanwhile, the economic data is starting to roll over and housing looks set to launch into another spiral lower. So what is a Bernank to do? Bluff the heck out of the markets.

He knows that the only way he can have cover for his printing party is to smash commodities because the rise in commodities is the biggest point of contention amongst the masses.

• Unfortunately, most people don’t delve deep enough into how the system works to have the serious moral and philosophical issues with the central planning system as I and many others do. The Bernank knows this. Bread and circus is a tried and true method. Problems emerge when the bread runs out. So the period we are in right now is huge for the Bernank and his merry band of mental patients. They don’t have to make any decision on more printing until June when the current fiasco ends. It is during this window when they think they can have their cake and eat it too. They can print like mad yet at the same time claim they are about to stop and maybe even tighten. Yeah, and the Easter Bunny is sitting next to me trading LinkedIn shares.

Kreiger contends this is The Bernank Bluff and he is milking it for all it is worth while at the same time orchestrating raids on commodity futures.

Kreiger further contends that this is just a massive psychological game against the investors class to keep them from the assets that will actually provide protection.

• Well Bernank you’ve got a month left. Make the most of it because after that you need to act. I can’t wait to see you try to tighten as the economy rolls over.

The reality is QE 2 is not the end of the money printing.

But then... you knew that already, right?

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On the topic of Quantitative Easing

Yesterday I talked about a trend that will continue next year: currency induced cost-push inflation.

Today I would like to talk about another trend you will see continue into next year: Quantitative Easing.

For almost 20 years now, the US Federal Reserve has been able to prevent market forces from correcting our economic imbalances by inexorably pushing rates lower.

This happened in 1991, 2001, and most notably in 2008.

These easing campaigns succeeded in boosting the economy in the short term by greatly increasing the amount of debt held by both the private and public sectors.

Each successful round was been enacted to prevent/delay the repercussions from the earlier effort.

The dot-com bubble was created. When it burst, rates were lowered to stimulate and created the housing bubble. When the housing bubble burst in the US, the Federal Reserve lowered interest rates to practically zero.

At this point, rates can go no lower.

So when that stimulus failed, the Federal Reserve has decided to bring on the heavy artillery in the form of “Quantitative Easing,” or as it is known in the vernacular, “printing money to buy government debt.”

By its own words, the Federal Reserve has said the goal of quantitative easing (QE) is to lower long-term interest rates. It is hoped that this will achieve what low short-term rates had not: an increase in stock and real estate prices, a rise in household wealth, and consequently greater consumer spending, economic growth, and job creation.

As the year winds down, it appears the Fed’s plan has backfired.

So far the selling pressure on long-term bonds is overwhelming the Fed’s buying pressure. Spiking rates (which move inversely to price) are powerful evidence that the bond bubble may be ready to burst. The Federal Reserve has thrown everything but the kitchen sink at the bond market to force yields lower, yet they have risen anyway.

Meanwhile the economy sputters, real estate continues it's downward slide in America and unemployment is not dropping.

Compounding the issue is a new Republican dominated congress which has come to power on the back of an austerity movement.

The US Federal Reserve is the only option to stimulate the economy right now.

One of the biggest obstacles facing that US economy will be the individual US States.

The worst recession since the 1930s has caused the steepest decline in state tax receipts on record. State tax collections, adjusted for inflation, are now 12% below pre-recession levels, while the need for state-funded services has not declined.

As a result, even after making very deep spending cuts over the last two years, states continue to face large budget gaps.

At least 46 states struggled to close shortfalls when adopting budgets for the current fiscal year. These came on top of the large shortfalls that 48 states faced in fiscal years 2009 and 2010. (for your information, the 2011 tax year began July 1 in most states)

States will continue to struggle to find the revenue needed to support critical public services for a number of years, threatening hundreds of thousands of jobs.

And if the State financial picture is bad, it pales in comparison to the municipal financial picture. Major American cities are in deep financial trouble.

There is no painless way out of this situation at this point.

Bernanke and the Federal Reserve are caught between the Scylla of deflation - which would liquidate the inefficient part of the economy - and the Charybdis of inflation.

A crystal ball is not required to see which the US Federal Reserve will choose in 2011.

Ben Bernanke has a PH.D in economics and his entire reputation is wrapped around be an expert on the Great Depression. He is an academic, and academics are very predictable.

When you go through graduate school you have to write a doctoral thesis, which will start your real career. Usually those thesis - if they are successful - lead to books and then more writings that branch off of the original thesis. Creative minds, and there is a difference between being imaginative and smart, then investigate new avenues of thought throughout their careers and come up with innovative theories and groundbreaking research.

That's what 'academic' life is all about.

Most of these 'academics' then spend the rest of their career circling around the theories behind their doctoral thesis. They remain anchored to it and don't deviate for the rest of their lives.

They can't.

Their entire professional reputation is wrapped around that thesis, it is their life's 'work'.

That is essence of Bernanke. He wrote a thesis claiming that the Great Depression happened because the Federal Reserve didn't lower interest rates fast enough after the stock market topped out in 1929 and because they failed to provide enough liquidity (printing of money) is the years after the crash.

There will be no deviation from this 'thesis'.

Bernanke has chosen the Charybdis of inflation - the whirlpool.

Quantitative Easing has only just begun.

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46 US State Governments Facing Greek-Style Deficits

In California they are gridlocked over how to close a $19 billion budget gap and are weighing the termination of the main welfare program for 1.3 million poor families or borrowing more than $9 billion in the bond market.

Illinois, tied with California for the lowest credit rating of any state, is diverting a rising portion of tax revenue to service debt.

Finances in Arizona, New Jersey, New York and other states show few signs of improvement.

In total Forty-six states face budget shortfalls that add up to $112 billion for the fiscal year ending next June, according to the Center on Budget and Policy Priorities, a Washington research institution.

“States are going to have to cut back spending and raise taxes the same way Greece and Spain are,” says Dean Baker, co- director of the Center for Economic and Policy Research in Washington. “That runs counter to stimulating the economy and will put a big damper on the recovery in the latter half of this year.”

It appears that across the United States, all that stimulus money is drying up and States don’t have a choice anymore, their problems are going to require major surgery.

The risk is that California ends up like Greece, with no one trusting that it can get its financial house in order, says Steve Westly, California’s Democratic treasurer from 2003 to 2007. “It has to be a combination of cuts and revenue increases,” he says.

Will the federal government hang the US States out to dry or will they bail them out like they did Wall Street?

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Marching headlong down the road to Q.E. to infinity

Some interesting comments to the last post about the stock market's wild ride. Thank you to those who emailed and posted.

Agree or disagree with my comments, here's a thought for you from Jim Sinclair.

When the DOW is down 500 points in the blink of an eye, this is considered extremely bad and needs to be investigated. And in this flash crash all Market orders placed are considered bad and are cancelled!

But on a day when the Dow is up 500 points in the blink of an eye, this is considered good and congratulations are in order. Yet in this flash boom, all Market orders placed are considered good?

Uh-huh.

Yesterday European leaders committed to do “whatever it takes” to defend the single Euro currency.

This is a repeat of what US policymakers were forced into in the wake of the Lehman Brothers collapse. Not until the US Treasury and Federal Reserve promised (in effect) to bailout every bank and financial institution that looked like it was sinking did the hurricane begin to abate.

Europe will be hope for a similar result from yesterday’s initiatives and the initial response of markets is encouraging, but this is not an entirely done deal and there is still much to come.

Euro nations have in effect taken another giant step down the road to fiscal and political union by agreeing to cross guarantee the loans of weaker nations. What is even more significant is that the European Central Bank has been dragged kicking and screaming into conducting a programme of quantitative easing – buying up public and private debt securities – similar to that already carried out in Britain and the US.

What is becoming increasingly clear is that all national debt is now going to be bailed out.

Next... all debt of individual US states will be bailed out.

Regardless of the first knee jerk market reaction, the fact of the matter is that we have taken the nuclear option of adding more debt to entities failing because of debt.

Steel yourself for more unrest, in markets and in currencies.

The reaction you saw in the markets is being spun as a mystery... and there for it's branded an anomaly.

No one wants to admit that it was a selloff of significance... and therefore indicative of further problems.

The truth of the matter is that what you saw here was a combination of computer based flash trading, below the horizon computer based exchanges, and algorithms gone wild.

It's proof that computer markets lack specialists and are ticking time bombs of illiquidity. This condition remains and you can be sure we will be looking for more repeat performances.

With the $350 billion the US Federal Reserve threw in to support the EU, we had about One trillion in Quantitative Easing initiated today.

And when you consider how much more will have to be thrown at currency markets to sustain the Euro at $1.29 (at which it must be sustained to declare any market success), and it's clear we are inescapably down the road to Quantitative Easing to Infinity.

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April Fool's Day

Life is full of signposts and I wonder if today will represent one of those markers.

Beginning in January 2009, and every single business day since then, the US Federal Reserve has been buying up Mortgage Backed Securities.

The program, which ends today, will have transferred $1.25 trillion of MBS 'on behalf' of the US taxpayer. This now represents the single biggest asset on the Federal Reserve's balance sheet, and backing up such liabilities as currency in circulation.

Think about that for a second.

As you know, the US housing market is not faring well and is expected to continue to drop in value. This means the US Dollar is collateralized more than half by rapidly devaluing, and in many cases cash flow non-producing houses and excess reserves.

At midnight last night the Fed's MBS program ended, and the market is now on its own for the first time in over one year.

What happens next is anyone's guess.

But with the Federal Reserve having gone all in and then reraised tenfold courtesy of fractional reserve banking, it is difficult to believe that the Fed will allow house prices to drop further.

Which is what is going to happen in the market sets interest rates on it's own.

Are we going to see the Fed immediately reinstitute QE at the first hint of mortgages at or approaching 6%?

Let's face it, a 1% widening in mortgage rates will be the equivalent of a several hundred billion loss in household net worth.

Meanwhile there is the growing concern of the debt problems of individual states.

California, New York and other states are showing many of the same signs of debt overload that recently took Greece to the brink — budgets that will not balance, accounting that masks debt, the use of derivatives to plug holes, and armies of retired public workers who are counting on benefits that are proving harder and harder to pay.

California’s stated debt — the value of all its bonds outstanding — looks manageable, at just 8 percent of its total economy. But California has big unstated debts, too. If the fair value of the shortfall in California’s big pension fund is counted, for instance, the state’s debt burden more than quadruples, to 37 percent of its economic output, according to one calculation.

Jamie Dimon, chairman of JP Morgan Chase, has warned American investors should be more worried about the risk of default of the state of California than of Greece's current debt woes.

Dimon told investors at the Wall Street bank's annual meeting that "there could be contagion" if a state the size of California, the biggest of the United States, had problems making debt repayments. Dimon believes California poses a greater threat than does Greece.

If markets force the weak hands, as they always do, will it be Bernanke and the printing press to the rescue? Or will the bond market be allowed to push interest rates up to punishing levels as is the current Greek experience?

And then there is the Canadian situation.

The Bank of Canada warned in late 2009 that up to 10% of Canadian homeowners might be in danger of losing their homes when interest rates started to rise from last week's historic lows.

In the United States, subprime represented far less than 10% of the US housing market. It's collapse triggered complete chaos in the housing market. Is Canada heading down the same path as our neighbours to the south? Are we looking at a mortgage meltdown somewhere down the road?

On the day of fool's, there is much to ponder.

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To Infinity and Beyond?

Two days ago I made a comment that "if [interest] rates stay low we will remain protected and secure."

It was a bit of a sarcastic comment because long time readers of this blog know I don't think interest rates are going to stay low at all.

One reader (jungberg) asked, in the comments section, what the chances were that the government will raise rates?

Let's be clear. Rates are going up. The Bank of Canada has sounded enough warnings to Canadians about that very fact to leave not doubt. The only question is: how high will they go?

I think without US intervention (more on that in a bit) they will go far higher than Carney would like... and he won't be able to prevent it.

It all has to do with the cost of money.

All Western governments are in record states of deficit. The global competition for money is about to heat up the bond market.

What's keeping things down right now is Quantative Easing.

Your mortgage rates are directly tied to the yields of the sale of US Treasuries, and right now those yields are artificially low. Very low.

They have been manipulated that low by US Federal Reserve intervention throughout 2009.

Three weeks ago we talked about a report from Eric Sprott, the Toronto-based money manager, which pointed out that the actual number of US Treasuries being sold to foreigners in 2009 was next to nothing and that the purchase of those Treasuries by the Fed was far higher than originally acknowledged by the government.

Of the $1.75 trillion in 2009 US Treasuries sales, only $200 Billion was actually bought by entities besides the US government.

As Sprott pointed out, the whole point of selling new US Treasury bonds is to attract outside capital to finance deficits or to pay off existing debts that are maturing.

In 2009 we had a situtation where the US Federal Reserve was printing far more dollars to buy Treasuries than they 'officially' announced they had planned to do. This amounted to a means of faking the Treasury's ability to attract outside capital. Since the US bought the vast majority of it's own Treasuries, the yield (interest rate) was kept artificially low. Only $200 Billion was actually sold to investors.

In 2010, the United States needs to fund $2.21 Trillion worth of Treasuries sales. Since $200 Billion of those Treasuries will be absorbed in the 'official' conclusion of Quantative Easing, it means in the 2010 fiscal year (November 2009 to October 31, 2010) the US will have to sell $2.01 Trillion in debt to the rest of the world.

So who going to buy them if there weren't enough buyers in 2009?

Either interest rates are going to have to jump dramatically... or the US is going to have to embark on Quantative Easing to Infinity.

Since November 2009 marked the start of a new fiscal year, we can now start to answer that question.

And the first bits of evidence coming in are disturbing.

Yesterday the latest US Treasury International Capital Flows data covering November 2009 were released (the date is about two months behind the current month).

The data reveals a huge surge in capital flows predominantly as a result of a massive buying binge in US Treasuries. The implication is that there is, presumably, a strong market for the purchase of US Treasuries.

The surge in purchases is so strong that the November data is the largest amount of purchases for any month since 2005 (reference this analysis by Jim Sinclair's Mineset).

(Note: the previous high in purchases of US Treasury's occurred during the month of June 2009 when $100 billion worth of Treasuries were purchased on net)

November 2009 topped that by another $18 billion. So all is good, right?

Not so fast.

Dan Norcini, who did the above referenced analysis, had the following comments:

• "Strangely enough, when you look into the breakdown of the Treasury buying by country, we see a decrease in the biggest buyer of US Treasuries, namely China. They sold about $9 billion worth. Japan compensated for that by buying another $11.4 billion. The biggest increase however came out of Great Britain where some $47 billion were added. Keep in mind that London is often the primary conduit through which foreign entities affect purchases of US Treasuries for the purpose of secrecy as that information generally does not get revealed until the Treasury revises the TIC data in June of each year.
  
  Call me cynical but we really have no idea who actually bought all those Treasuries through London offices.
  
  In times past the revisions have seen many of those purchases being credited to China but that does not guarantee anything of the sort this time around, especially with China being a net seller this month.
  
  We also have a decent sized increase in Treasury buying out of those Caribbean based banks.
  
  Were it not for the binge in Treasury buying, the Agency, Corporate Debt and Equity categories would not have been sufficient to fund the negative balance of trade. This of course will be spun as a vote of confidence for the US Dollar as the spinmeisters will step up and proclaim that the world still has a strong appetite for US debt. Personally I think the Fed is buying the Treasuries."

Norcini's suspicions can't be confirmed until the June numbers come out. Last year the US Federal Reserve wasn't forthcoming with the true extend of how widespread and extensive the purchasing of their own Treasuries was, so it's not that much of a stretch to imagine the same deceptions are playing out again this year.

And Sprott called what was going on in 2009 a virtual 'ponzi scheme'.

If the Fed has embarked on QE to infinity - look out. Spiking interest rates will be the least of our worries if that's the case.

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More US Quantative Easing?

A report out from Reuters indicates that the US Federal Reserve is discussing re-entering the mortgage-backed securities market later this year if its buying power is needed to hold down interest rates.

The Federal Reserve is supposed to end its $1.25 trillion agency MBS purchasing program at the end of the first quarter of 2010.

Fed officials, however, "are prepared to contemplate changes if need be, depending on conditions in the economy, housing finance and in financial markets more broadly," according to a Market News story written by Steven Beckner.

"Among the options that has been discussed, say people in a position to know, is doing additional MBS purchases."

When the Fed stops buying at the end of the first quarter, rates in the market are widely expected to rise, pulling mortgage rates higher as well.

The question becomes... how long before confidence in the US dollar is lost when the massive debt is expanded at the same pace as last year?

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Cramer Praises Bernanke

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Ahh... Jim Cramer.

Faithful readers will recall the imfamous Mr. Cramer as the wild eyed, bald headed, investment gonzo-schtick king from CNBC who was utterly eviscerated by Jon Stewart back in March.

If you missed the classic piece, Stewart took Cramer (and CNBC) apart for his bad investment advice which totally missed the market crash. You can see the Steward Daily Show segment that started it all here...



Unabated Cramer has continued on with his investment show (Mad Money) and continues to be pillored for his not-so-prescient stock market advice.

Now comes word that the King of Poor Stock Picks penned an OP-Ed piece in the New York Magazine this past week and once again is going against the flow of popular opinion.

While many (including your faithful scribe) are highly critical of US Fed Chairman Ben Bernanke's policies of quantative easing (and the potential they create for high inflation), Cramer hearld's the Federal Reserve Chairman as a vertible saviour. From the New York Magazine article...

"More than Obama, more than Geithner, more than anyone, it is the once-maligned Federal Reserve chairman who has saved us from the second Great Depression. ... I'll just come right out and say it: Ben Bernanke will go down as the greatest Federal Reserve chairman in history. The soft-spoken academic who has toiled in the shadows of his legendarily self-promoting predecessor, Alan Greenspan, will be known as the man who averted the Great Depression Two, a sequel that could have eliminated the United States as a world financial superpower and reduced us to this century's Britain. Make no mistake about the parentage of this success story."

"President Obama pushed through a stimulus plan that will ultimately help the economy later this year, and Treasury Secretary Tim Geithner chose to adopt Bernanke's strategy of allowing banks to raise money themselves rather than bowing to calls from politicians and pundits to have taxpayers bail them out even more than they already had. But it was the 55-year-old former Princeton professor who spent his teaching career studying how the Great Depression could have been prevented who deserves the bulk of the credit."

"As credit froze and production and stocks plummeted as fast as they had between 1929 and 1932, Bernanke broke ranks with the complacency crowd and the inflationistas and relied on the lessons he'd learned back at Princeton to quickly take interest rates to an unheard-of zero percent. He turned on the Fed's printing presses, forcing dollars into the banking system, and began to buy $500 billion in mortgage bonds to force rates down to stop runaway foreclosures and keep people in their homes. That was the most aggressive policy change in the Fed's history, something that amounted to nothing short of an economic putsch that bridged the interregnum between presidents and continues to this day. And we needed it."

Cramer is a regular writer for New York Magazine and with this article he has provided an astonishing defense of Bernanke and today's central banking strategies. We will wait and see if he changes his tune if Bernanke's "aggressive policy change" produces massive inflation. I wonder how hopeful Cramer will remain if, in reaction to inflation, former Fed Chairman Paul Volcker or some other tough guy steps in and raises interest rates through the roof, setting off another slump.

Jon Stewart, I'm sure, has Jim Cramer set on TIVO. Where else does your material write itself?

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